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Rock around the clock :An agent-based model of low-and high frequency trading

  • Sandrine Jacob Leal

    ()

    (Cerefige, ICN, Business School,Gredec)

  • Mauro Napoletano

    ()

    (Ofce,Skema Business school,Scuola superiore Sant'Anna)

  • Andrea Roventini

    ()

    (Universita di Verona, Scuola superiore Sant'Anna)

  • Giorgo Fagiolo

    ()

    (Scuola Superiore Sant'Anna Pisa, Italy)

We build an agent-based model to study how the interplay between low- and high- frequency trading affects asset price dynamics. Our main goal is to investigate whether high-frequency trading exacerbates market volatility and generates ash crashes. In the model, low-frequency agents adopt trading rules based on chrono- logical time and can switch between fundamentalist and chartist strategies. On the contrary, high-frequency traders activation is event-driven and depends on price fluctuations. High-frequency traders use directional strategies to exploit market in- formation produced by low-frequency traders. Monte-Carlo simulations reveal that the model replicates the main stylized facts of financial markets. Furthermore,we find that the presence of high-frequency trading increases market volatility and plays a fundamental role in the generation of ash crashes.The emergence of ash crashes is explained by two salient characteristics of high-frequency traders, i.e. their ability to i) generate high bid-ask spreads and ii) synchronize on the sell side of the limit order book. Finally, we find that higher rates of order cancellation by high-frequency traders increase the incidence of ash crashes but reduce their duration.

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Paper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 2014-03.

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Date of creation: Feb 2014
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Handle: RePEc:fce:doctra:1403
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